Hate to be a downer on Christmas Eve, but about the stock market

Does anyone have an idea what is up? Is it a Bitcoin thing where everyone got too excited? Maybe Trump isn't the miracle we thought he was for the economy? I'm seeing predictions that it's going to get worse come the new year and opposite predictions that the market will rise 25% next year to correct for this mini slump. Any bets?

I think the market values stability and consistency, the current administration is not capable of that. I know very little about these things and I won't blame Trump for rising interest rates but our new trade war and now government shutdown seems to be of his doing.

I'm a fiscal conservative, socially liberal, I suppose left leaning independent (titles are always weird to me). I probably would be republican if not for social issues. I would have strongly considered Romney instead of Hilary Clinton. So that being said... do you think many Trump supporters that are more moderate are regretting their vote for him?

I can’t imagine how stressful it must be right now to be a trader on Wall Street. How do you make investment decisions or even hedge your risks when we have a trade war with China, talk of firing the Fed Chairman, and now a government shutdown on Friday.

And then Mnuchin calls bank CEOs to reassure them, which has the opposite effect.

I’m apolitical, so I just look at this from a planning standpoint: if you have zero confidence in building a forecast for the next six to nine months, the market is going to default to a negative outlook.

I think history is pretty clear that there are very few people (like, maybe a couple) who have shown they can predict the market accurately over any type of extended period of time. So I definitely don't pretend to have any reliable prediction.

That being said, I'm definitely anticipating a downturn. It just doesn't change my investment plan (invest in index funds over time and hold 'em.) It does get me a little excited, though, that stocks are going on sale while we're in the accumulation phase of life!

I don't think this is a 2008-style downturn because unlike them, we don't have a "cataclysmic" event that's hitting us right now, like subprime mortgages. (We do have plenty of those in the horizon though). I think we'll see a few more huge pops into next year before the next downturn.

WITH THAT SAID, hedge yourself / diversify properly, if you're going to put money anywhere. Don't put all your money in VIX and XIV lol. I'm staying cash and putting all my time in building my startup. A whole lot less stressful than trading at the moment.

I'm curious, does market volatility improve the performance of index funds? I'm no mathematician, but it seems like the point of index funds is to buy a lot of shares when they are cheap and not many when they are up. So do big dips help you accumulate cheap stock and big spikes keep you from buying too many expensive shares?

Index funds track the performance of the market as a whole. They are generally highly automated and thus offer very low fees. Basically, you use them to invest in business as a whole and don't have to worry about the performance of specific companies or even sectors. When the market goes up, they go up; when the market tanks, they do as well, though there might be some small time lags involved. I don't see why market timing would be more successful with index funds than with a diversified equity portfolio, but then I'm certainly no expert. Most financial advisers caution against a market timing strategy because it is simply not reliable unless you own a time machine.

So do big dips help you accumulate cheap stock and big spikes keep you from buying too many expensive shares?

I believe @amacbean is a proponent of dollar cost average investing. Basically, you average your risk over time by investing the same amount each month, say $100. When the market is low, that $100 buys more shares. When the market is high, it buys less. Over the long haul of decades, the theory of dollar cost averaging says that you will end up with a higher valued portfolio than if you invested the $1,200 annual sum all at once.

Peter Lynch conducted an interesting related study on buying at the peak and holding the stock for the long-term.

Over the long run, however, market timing doesn't matter much. Lynch conducted a study that examined an investor who invested $1,000 every year at the market's highest point (worst possible time to buy), as well as an investor who invested $1,000 every year at the market's lowest point (best possible time to buy). Over a 30-year period, the difference was quite small -- 11.7% annualized returns versus 10.6%.

I don't think this is a 2008-style downturn because unlike them, we don't have a "cataclysmic" event that's hitting us right now, like subprime mortgages. (We do have plenty of those in the horizon though). I think we'll see a few more huge pops into next year before the next downturn.

Yes, I meant to say dollar cost averaging, thank you. 🙂 I was hoping a mathematician like you would weigh in and tell us if dollar cost averaging does better when the market is volatile.

This guy says:

A dollar cost averaging strategy works only if you keep investing through thin. This means that it is essential to invest when there is blood in the streets. Blood in the streets means that most others are selling in panic of what might happen next and nobody wants any kind of relation with stocks. A similar situation happened in 2001 and 2009. Those who have been constantly investing in stocks during the last 10 or 20 years, month after month, did well. However, if you stop investing during a recession because you prefer to save a bit of cash in case you get fired, then index investing should be completely avoided because extremely risky and will lead to bad returns.

I was hoping a mathematician like you would weigh in and tell us if dollar cost averaging does better when the market is volatile.

Investing always has risks and reducing the probability of loss isn’t a guarantee of loss avoidance.

I realize that’s a “Duh, really?” statement, but people get in trouble when they assume otherwise.

If you’re twenty seven years old and not retiring for forty years, dollar cost averaging index funds means that you are buying shares cheaply during recessions and in forty years your return on those shares should be greater than if you had bought them during a stock market rally.

But what if you’re now 67 and you want to cash out and it’s another recession?

Do you “dollar cost average” your withdrawals by selling index shares each month, rather than taking an annual or lump sum withdrawal?

I’ll leave the final word on dollar cost averaging to Jack Bogle, the “father” of index funds.

When actually drilling into details, it's my opinion that the Obama administration's execution worked better than Romney's managed bankruptcy would have.

In my view, the economy performs better, counterintuitively, under most democratic administrations than republican. When I hear Bill Clinton or Barack Obama explain it, I can understand the explanation. When George W, Reagan, or Trump explain it, I feel like there's a lot of hand waving. Do things really trickle down from the rich? Or does fiscal conservatism honestly mean keeping wages and benefits low for the poor and middle class so that they end up not having the spending power that would fuel the economy?

While it may sound plausible to some, the track record of trickle down economics is mostly negative. Reagan's tax cuts on the rich are sometimes given credit for ending the 1980 recession, but causality is unclear as he also increased government spending and tripled the national debt, which was a standard Keynesian move. If you look at the long term since then, middle and working class wages have mostly stagnated and the gap between rich and the rest has widened, despite the promises of both Bushes. We also know that Trump's tax cut overwhelmingly went to stock buy-backs, though it's probably too soon to gauge the trickle down effects, if any. We have seen some wage gains in the past year, but this is almost certainly due to low unemployment, which preceded the tax cut.

OTOH, there is one area in which money does trickle down: Republican mega-donors give large contributions to the campaigns of tax cutting candidates. They are also likely to find lucrative employment as corporate lobbyists when they leave office. So money trickles down to some, though in other countries, this is known as corruption.

I just saw yesterday's numbers and something else occurred to me that I haven't seen discussed much recently: algorithmic trading. I'm wondering whether the volatility we've been seeing recently might have more to do with trading software than anything else. Certainly, high-speed trading thrives on (and feeds) big fluctuations. I'm guessing that AI is increasingly replacing good old-fashioned algorithms, which could make market behavior even more inscrutable. AI seems much more of a black box than explicit algorithms, so I'm wary of its effects. Does anyone know whether there is any specific regulation of AI driven trading? Do you think there should be?

Some of the hedge funds actually moved their server a few feet closer to the exchange server. Consequently, the picosecond(?) difference in trading time allowed their computer to see their competitors trades and execute a trade, based on that intel, before their competitor’s trade was processed.

They’ve since put in trading hold controls to eliminate those unfair advantages, but the idea that a hedge fund could buy a stock in a fraction of a second and then turn around and sell it before the second was up still boggles my mind.

Yes, I read it some time ago. But as disturbing as it was, at least the basic principle was comprehensible: arbitrage carried to ridiculous extremes. I don't know anything about the newer AI techniques that traders are using, but what worries me is the likelihood that the decision making is opaque, based on patterns that only a neural net can see. I'm not an economist, but I suspect that could cast doubt on the basic assumption of rationality in the market, without which there's no longer any theoretical reason to expect good outcomes globally. If the decision making cannot be codified in human form, it becomes more difficult to impose regulation to constrain the consequences. I should add that I don't know that any of this is actually happening--one would think that traders would be reluctant to "just let the computer decide"--but who knows? I do know of some AI managed funds, but I don't know whether there are enough of them to move markets or whether they have built-in limits on trade size or speed.

Thanks for the link. It sounds like my fears may be a bit premature, which is just as well. Still, I think the mere prospect gives us reason to devote more attention to the general problem of making AI more transparent and accountable.

At dinner the other night I sat by someone fascinating who said last year AI scientists discovered two AI machines had found existing languages too inefficient and had developed their own and were talking back and forth in a way the scientists could not understand, so they unplugged it.

That sounded like it could very well be true and my blood chilled. Just think of how imprecise our words can be. I chased it down to find out more and it seems to be one of those things that has a grain of truth but is (so far) exaggerated.

I remember reading about that and thinking that it was immensely cool, but not especially threatening. It would not be surprising if adversarial generative networks could devise data compression algorithms that haven't occurred to humans. But in any event, this sort of stuff is easily misinterpreted--the bots weren't talking in code to evade eavesdropping or understanding by humans. They just evolved a different means of exchanging very specific information, which is fascinating in and of itself, but nothing to lose sleep about. In fact, I'm not even sure anyone demonstrated that the encoding was more efficient than standard English. In any event, it's a gross exaggeration to say that they "developed their own language." OTOH, it does exemplify the more general problem of transparency, i.e., understanding why AI does what it does.

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